Tax agency in desperate need of extensive reform

Tax agency in desperate need of extensive reform

Agam Fatchurrochman and Edi Suhardi, Jakarta

One of the puzzles of the Indonesian economy has been the tax
office. True, the Directorate General of Taxation has played an
important role as the prime motor of the economic engine and by
consistently collecting more and more state revenue.

However, numerous studies on public and investor confidence in
the tax agency, including studies by Indonesia Corruption Watch
(ICW, 2001), Partnership for Governance Reform (Partnership,
2002), Transparency International Indonesia (TII, 2005) and
Political Economy Risk Consultancy (PERC, 2005), have shown that
the tax agency is consistently perceived as one of the most
corrupt institutions in the country.

Sadly, there has been nothing in the way of a positive
reaction by the tax office to these studies.

It is also true that since the last round of tax law reforms
in 2000, the Directorate General of Taxation has introduced some
major reform initiatives, including online payments, electronic
filing and an integrated information system for tax
administration. There also has been a joint initiative with the
Ministry of Finance and the Commission of the Tax Ombudsman,
which recently signed an agreement with the Corruption
Eradication Commission (KPK) on law enforcement.

The idea behind these reforms was to simplify procedures and
to strengthen the rule of law and social justice. However, these
administrative and enforcement initiatives have not yet touched
on the root of our taxation problems, which is tax extortion.

The most potent tax problem in developing countries is tax
extortion, where tax officials actively look for economic rents.
This is different from tax bribery, where a taxpayer initiates a
bribe to receive concessions.

Coordinating Minister for the Economy Aburizal Bakrie, as a
former chairman of the Chamber of Commerce and Industry, is well
aware of this reality.

President Susilo Bambang Yudhoyono and his economic team have
placed tax problems high on their agenda of action. The
government should take two bold steps.

First, the privatization of the tax administration and audits.
At a glance, this idea is perhaps revolutionary, although the
philosophy of our tax collection, self-assessment and withholding
(e.g. a company withholds employee income tax payments) is
obviously a privatization concept, whereby the state entrusts tax
collection to private institutions.

Further privatization is needed to cut direct contact between
taxpayers and tax officials by privatizing tax audits. Direct
contact between tax auditors and taxpayers is empirically proven
to be the first contact for extortion. Therefore, in a situation
whereby the reputation of the tax office is placed in severe
doubt, the government and local trade associations can jointly
assign an independent auditor to conduct a tax audit on behalf of
the tax agency.

Consequently, there will be no contact between taxpayers and
tax agents. Direct contact is entirely reduced to between the
assigned auditor and tax agency. The tax agency still maintains
the right to conduct peer reviews, where the tax agency can
perform a review to ascertain the compliance of a tax auditor
with audit standards, and, if necessary, can perform its own tax
calculations by borrowing tax documents from the auditor.

This concept is not entirely new in our public finance
practices. A precedent was when the Supreme Audit Agency (BPK)
appointed PriceWaterhouseCoopers to conduct an audit on its
behalf in the Bank Bali scandal. Other privatization cases
include the government appointing Societe Generale de
Surveillance, and later Sucofindo and Surveyor Indonesia, to
conduct customs inspections of exports and imports on behalf of
the customs service.

In addition, as a general precaution for preventing direct
contact between taxpayers and tax agents, the government should
encourage the practice of certifying tax returns by tax
consultants who represent clients dealing with the tax agency.

The U.S. experience shows that tax consultants "enforce"
clear-cut tax laws and "exploit" ambiguous tax rules by taking a
pro-taxpayer stance. But tax compliance is higher when tax
consultants are subject to harsh penalties for breaking tax laws.
With so much at stake, tax consultants will act more as good
"enforcers" and comply with tax regulations.

Consequently, the probability of collusive tax deals between
tax consultants and tax agents is reduced and taxpayers will
receive protection from tax extortion as well, since there is no
longer direct contact with tax officials.

Second, legal steps must be taken to stop tax extortion by
stepping up the roles of the KPK and the BPK. The KPK has the
right to take over investigations of public complaints filed with
the tax office. The commission can investigate the criminal
aspects of tax extortion and question the origins of the wealth
of the tax officials in question.

It also can work with the BPK to exert the BPK's semi-judicial
power in pursuing state losses from tax extortion.

Finally, a medium-term systematic step should be initiated by
modernizing the management of the tax office, including paying
tax officials according to market rates for their skills, but
threatening them with heavy penalties for corruption.

As a first step, spinning off the Directorate General of
Taxation from the Ministry of Finance could be considered one
viable remedial measure.

Agam Fatchurrochman is studying at Nottingham University's
School of Business in the UK. Edi Suhardi is an observer on
reform.